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Hedge funds are on track to record their best monthly performance in one and a half years, in the middle of what their largest investor has called a “major industry shake-out”.

The $1.3 trillion (€921bn) industry had made 2.7% in the month to May 27, according to database Hedge Fund Research's investable hedge fund index, which is considered an early indication of the wider industry's performance.

Not since November 2007, when funds made 2.8%, has the industry done so well. So far this year hedge funds have made their investors 5%.

Multi-strategy funds have been the best performers in May, up 6.1%, followed by funds that arbitrage the values of related instruments, which made 5.9%. The funds that have struggled the most so far this month have been those investing in distressed securities, which are down 1.6%, and global macro portfolios, which have lost 1%.

One fund of hedge funds manager said: "Things have thankfully stabilised in the industry, but 5% this year isn't outstanding compared to what the industry has done in the past."

Until the start of 2008, hedge funds had made an annual average of 14.2% each year since 1990, when HFR began monitoring their performance. However, last year was the industry’s worst on record and funds lost a record 19.3% on their investments and investors pulled about $154bn from them, according to HFR.

By the end of 2008, the industry's average annual return since 1990 had dropped to 12.5%.

However, Peter Clarke, chief executive of Man Group, the world's largest investor in hedge funds, said:
"The hedge fund industry has shown signs of stabilisation early this year, with overall industry performance in positive territory...and outflows slowing.

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"However, it is clear that a major industry shake-out is underway, precipitating a sharp fall in the number of managers, led more by attrition than consolidation, as many mangers have not been able to survive the decline in assets."